India has been grappling with an increase in non-performing assets (NPA) and defaults of loans since at least the 1990s. As per recent reports, gross NPAs of public sector banks have doubled in the last 7 (seven) years,1 which is indicative of the issues being faced by lenders against recalcitrant borrowers.
To protect themselves in the event of a default, lenders have increasingly relied on seeking extensive security packages for loans including mortgage over immoveable properties, hypothecation over receivables, pledge of shares, personal guarantees, corporate guarantees and post-dated cheques. However, the real challenge arises when lenders try enforcing the security against borrowers. Litigious borrowers, delays before courts and high litigation costs are all roadblocks to lenders seeking to recover their dues through enforcement of security.
Through this article, we have provided an overview of different avenues of security enforcement and recovery of dues available to lenders. In our view, a combination of different proceedings needs to be initiated against the borrower for effective results, depending upon the facts of each case.
A. CIVIL SUITS
The Code of Civil Procedure, 1908 ("CPC") has multiple provisions that creditors can take advantage of, for recovery of debts. Creditors may file a commercial suit for recovery and/or enforce their mortgage and other security.
A suit dealing with a "commercial dispute" as defined under section 2(c) of the Commercial Courts Act, 2015 ("Commercial Courts Act") which meets the designated pecuniary limit, will constitute a commercial suit which can be filed before designated commercial courts. In terms of the Commercial Courts Act, commercial disputes include ordinary transactions of bankers and financers, agreements relating to immovable property used exclusively in trade or commerce, and subscription and investment agreements pertaining to the services industry including financial services.
i. Wider reliefs can be claimed
One of the primary advantages of filing an action before civil courts is that the reliefs sought by lenders can be moulded as per the facts of the case. The powers of a civil court are wide unlike that of the National Company Law Tribunal ("NCLT") or the Debt Recovery Tribunal ("DRT").
Today, courts have become more proactive in allowing reliefs such as directions for disclosure of accounts and forensic audit of the borrower and its promoters, appointment of receivers, deposit of receivables from the secured property, garnishee orders and in exceptional cases, injunctions restraining the promoters / directors of the borrower from travelling abroad without permission from the court. Therefore, the nature of reliefs that can be obtained from civil courts are wide ranging and can be tailor made to suit the exigencies of a particular case.
Obtaining interim relief against the borrower may be enough in some cases to pressurise the borrower to come to the table with a viable and mutually acceptable proposal for clearing the dues and thereby dispelling the long-standing belief that the recovery is only possible after a decade long trial.
ii. Reduced timelines for deciding commercial suits
Lenders are often discouraged from filing civil suits due to the long delays before courts. While this is an undeniable downside of civil suits, there are now provisions that have been introduced in the CPC with a view to cut down the delays in commercial suits.
The first provision of note with respect to commercial matters is the outer time limit of 120 (one hundred and twenty) days mandated under the CPC for defendants to file their written statement, failing which their right to file a written statement will be forfeited. Unlike the outer time limit of 90 (ninety) days for filing written statements in regular suits where the Supreme Court has held the time limit is directory and not mandatory2, in commercial matters, the Supreme Court has held that the outer limit of 120 (one hundred and twenty) days is mandatory.3
The second important amendment in the context of commercial matters is the provision for seeking summary judgment under Order XIII A. Where the Court is of the opinion that the plaintiff or defendant has no real prospect of succeeding in its claim and there is no compelling reason why the suit should not be disposed off prior to recording oral evidence, it may give a summary judgment against the plaintiff or defendant.
The above provisions, if pressed into action, may help reduce timelines in civil cases significantly.
A well-known downside of civil suits is the costs involved. Apart from the costs that arise from long drawn legal proceedings, in many states court fee is payable ad valorem i.e., a percentage of the claim amount. In the lending space where facility agreements and consequent defaults often involve large amounts, the court fee payable may be significant.
Though the Commercial Courts Act has made "costs follow the event" principle (i.e., the unsuccessful party has to bear the costs) the general rule4, in practice, courts are generally reluctant to grant to the successful party the entire costs.
A. THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002 ("SARFAESI Act")
Where a debt is declared as a Non-Performing Asset ("NPA"), the SARFAESI Act empowers the secured creditor i.e., the bank or financial institution to take steps with respect to enforcement of security including taking possession of the secured assets of the borrower and appointing a receiver.
i. Lender in control
SARFAESI Act continues to be a recourse often favoured by banks due to the the ability of the lender to stay in control over the process of sale of the secured assets. Unlike in the corporate insolvency resolution process under Insolvency and Bankruptcy Code, 2016 ("IBC"), where decisions are taken collectively by creditors of the corporate debtor (depending on the value of the outstanding debt of each creditor), the SARFAESI Act sets out a framework for recovery of debt by a particular secured creditor and enforcement of security in relation to the same.
The primary objective of the SARFAESI Act is to enable the creditor to take control over the secured asset and realise the same without the intervention of the court. In keeping with this objective, section 13(4) of the SARFAESI Act provides that if the debtor does not make full payment of the dues within the period specified under the notice issued by the creditor under section 13(2) of the SARFAESI Act, the secured creditor can take over secured asset including the right to transfer and/or take over the management of the business of the borrower.
ii. Pre-deposit to file an appeal
The SARFAESI Act provides that if the borrower wishes to file an appeal against the order of the Debt Recovery Tribunal ("DRT"), he will have to deposit 50% (fifty) percent of the debt due from him. The Appellate Tribunal may reduce this up to 25% (twenty-five) percent of the debt due for reasons to be recorded in writing.
The requirement for pre-deposit has been strictly construed by the courts. The Supreme Court has held that the deposit is a pre-condition for filing an appeal before the Appellate Tribunal, and it cannot be waived by the high court even under Article 226 of the Constitution.5 This ensures that frivolous appeals are not preferred, and the banks / financial institutions are secured at least to the extent of 50% (fifty) percent of the debt due during the appeals process.
i. Limited applicability
The SARFAESI Act is not applicable to all lenders - it is only applicable to certain categories of banks and financial institutions as defined under the SARFAESI Act. It is also not applicable to unsecured creditors. Further, action against the borrower can be initiated only once the account becomes an NPA.
ii. Delay before DRT
Though the SARFAESI Act imposes strict timelines for disposal of cases by the DRT, there are inordinate delays in obtaining relief against borrowers due to large number of vacancies in the DRTs.6 These delays in obtaining relief can lead to value erosion of the asset.
iii. IBC prevails over SARFAESI
It is now settled law that creditors are not barred from initiating parallel proceedings under the SARFAESI Act and under IBC.7 However, it is pertinent to note that once an application is admitted by the Adjudicating Authority under the IBC, the moratorium in terms of section 14 of the IBC will kick in and any proceedings initiated by the creditor under the SARAFAESI Act will be automatically stayed. Further, a secured creditor who has taken physical possession of the mortgaged property before the admission of insolvency proceedings must hand over custody of that property to the Interim Resolution Professional.8
In facility agreements where there is an arbitration clause present, lenders can explore initiating arbitration proceedings against the borrower for recovery of the outstanding amounts.
i. Obtaining Interim relief may be more cost-effective
Lender can obtain interim relief from the Court through an application under section 9 of the Arbitration and Conciliation Act, 1996 ("Arbitration Act") at the very outset, which may be less expensive than filing a commercial suit and obtain interim relief therein.
ii. More control over the process
One of the hallmarks of arbitration as a dispute resolution process is party autonomy and lenders can use this to their advantage. Parties have more control over the procedure to be followed by the arbitral tribunal in deciding the dispute and can appoint arbitrators with sector specific knowledge making the process potentially more effective and efficient. Further, since arbitrators are appointed solely to decide the matter in question, proceedings are more efficient as opposed to court proceedings where there is more uncertainty on when the matter will be taken up by the court.
iii. Shorter timelines
Arbitration proceedings may conclude faster than a civil suit and the award passed in an arbitration is deemed to be a decree of a civil court for the purpose of enforcement.
The Arbitration Act contains several provisions intended to reduce timelines. The Arbitration Act provides that awards in domestic arbitrations must be passed within 12 (twelve) months from the date of conclusion of the pleadings.9 This timeline can be extended by 6 (six) months by mutual agreement between the parties. For any further extension of time, parties will have to apply to the court. Parties may also opt for a fast-track procedure under the Arbitration Act, where the arbitrator shall decide the dispute between the parties based on documents only and only call for an oral hearing if necessary.10 An award under the fast-track procedure must be passed within 6 (six) months from the date the arbitral tribunal enters upon reference.
Further, in agreements where arbitration clauses are included, lenders can consider including provisions for the arbitration to be administered by an arbitral institution which may help the proceedings run more efficiently.
i. High costs
Arbitrations can often be expensive depending on the fee charged by arbitrators, and in the case of institutional arbitrations, the fees to be paid to the institution. However, it may be noted that under the Arbitration Act, the general rule is that the unsuccessful party must pay costs to the successful party.11 If the arbitrator decides to the contrary, he / she will have to record reasons in writing.
Not all subject matters are arbitrable. For instance, matters such as enforcement of mortgage are not arbitrable and lenders will have to approach the Court separately through a civil suit for enforcement of mortgage.12
A. INSOLVENCY AND BANKRUPTCY CODE, 2016
A remedy now frequently being used by lenders against defaulting borrowers is to file an application before the NCLT under the IBC for insolvency resolution of the borrower. The insolvency regime in India is a "creditor in control" model, unlike in other jurisdictions such as the United States where the debtor continues to be in possession of the company. This makes the IBC an attractive proposition for lenders, especially when they constitute a large share of the borrower's overall debts.
i. Rate of recovery higher than other modes
Though the IBC and its implementation are not without its problems, it still has the highest percentage of recovery of debt compared to other modes of recovery such as the SARFAESI Act and the Lok Adalat.13
As per RBI's report on trend and progress of Banking in India, for FY 2019-20 lenders were able to recover INR 104117 Crores through IBC making the recovery rate 46.3%, whereas recovery through Lok Adalats was 6.2%, DRTs was 4.9% and SARFAESI Act was 17.4%.14 Further, notwithstanding the suspension of initiation of fresh insolvency proceedings under the IBC for an year from March 2020 till March 2021 and covid-related debt being excluded from default claimed by lenders, IBC was still one of the major modes of recovery in FY 2020-21.15
Additionally, it has been reported that as of 31 July 2021, as many as 14,510 cases involving defaults of INR 5.13 lakh crore were withdrawn from various benches of the NCLT before the applications were admitted by the adjudicating authority.16 This suggests that, though the IBC is not meant to be a recovery mechanism, it is proving to be a crucial tool to push promoters who are fearful of losing control over the company into repaying debts before the insolvency applications are admitted by the NCLT.
It has also encouraged settlement between creditors and corporate debtors after initiation of corporate insolvency resolution process ("CIRP"). The Insolvency and Bankruptcy Board of India ("IBBI") has reported that 4946 CIRPs had commenced by the end of December 2021 and of these, 714 have been settled on appeal or review and 562 have been withdrawn under section 12 A of IBC.17
ii. Avenue for revival of corporate debtor
With the enactment of the IBC, creditors have the option to revive the corporate debtor and attempt to maximize the value of its assets by inviting resolution plans. Provisions such as moratorium after admission of the insolvency application and power of the Resolution Professional to apply to the NCLT to terminate onerous contracts are all conducive to attempt to revive the corporate debtor. Therefore, where lenders feel that the asset has value, and they have a significant share of the overall debt of the corporate debtor so that they can control the CIRP process, they can attempt to revive the corporate debtor, instead of following an adversarial process like a civil suit.
As per the data published by IBBI, the IBC has rescued 457 corporate debtors as of December 2021 through resolution plans, with assets valued at 1.51 lakh crore.18
One of the major issues plaguing the IBC regime is the issue of delay in the conclusion of the CIRP process, which is contrary to the objectives of the statute and has even been noted by the Supreme Court in Ebix Singapore Private Limited v Committee of Creditors of Educomp Solutions Limited & Anr.19
A report by Alvarez and Marsal states that as of 31 July, 2020, a total of 19,844 cases were pending before NCLT including 12,438 cases under IBC.20 NCLT benches of Delhi and Mumbai, which have the highest number of insolvency cases, have an average resolution time of more than 475 days, which is above national average of 440 days.21 Such inordinate delays may cause commercial uncertainty, degradation in the value of the corporate debtor and increase costs.
Another issue that arises is inter-creditor disputes, where creditors file applications before the NCLT challenging the claims of another creditor, leading to further delay and expense.
ii. Uncertainty in law
Since the IBC is a relatively new statute, there are frequent changes in the law which sometimes lends further confusion and delay in matters. Though it has contributed to some chaos in the past, we expect this to not be as much of an issue in the next few years once the law becomes more settled, and the legal fraternity is more familiar with the provisions and their application.
A. REMEDIES UNDER CRIMINAL LAW
In suitable cases, lenders can also invoke the criminal machinery against a borrower where the borrower has committed fraud by siphoning of money or has made material misrepresentations to the lenders. Another avenue for criminal proceedings is filing proceedings under section 138 of the Negotiable Instruments Act, 1881 if the cheques provided by the borrower for repayment of debt are dishonoured.
However, initiating criminal proceedings must be considered carefully. While they are an extreme pressure point for borrowers; once they are initiated, the lender will not have control over the process. Further, it may also lead to counter-complaints and prove as a deterrent to potential buyers for the secured assets which the lenders may want to sell and recover their dues.
Over the last couple of decades, the government has taken several steps in an attempt to stem the rising tide of bad debt. As a result, today there are multiple avenues that a creditor may explore to recover debts. To make recovery truly effective, multiple proceedings may have to be invoked by lenders under different statutes, depending on the facts of the case. However, each avenue for recovery comes with its own set of advantages and pitfalls and there cannot be a "one size fits all" approach. It is therefore critical for lenders to have a proper litigation strategy in place to ensure that their internal rate of return is secured with cost effective and result oriented litigation.
1. Time of India, Gross NPAs of public sector banks double in last seven years, SBI tops the list, Available at: Gross NPAs of public sector banks double in last seven years, SBI tops list - Times of India (indiatimes.com)
4. Section 35 of the Code of Civil Procedure, 1908, as amended by the Commercial Courts Act, 2015.
5. Narayan Chandra Ghosh vs. UCO Bank & Ors., (2011) 4 SCC 548
7. Punjab National Bank v. Vindhya Cereals Pvt Ltd Company Appeal (AT) (Insolvency) No. 854 of 2019; Rakesh Kumar Gupta v. Mahesh Bansal Company Appeal (AT) (Insolvency) No. 1408 of 2019
8. Encore Asset Reconstruction Company Pvt. Ltd. v. Ms. Charu Sandeep Desai 2019 SCCOnline NCLAT 284
9. Section 29A, Arbitration and Conciliation Act, 1996
10. Section 29B, Arbitration and Conciliation Act, 1996
11. Section 31A, Arbitration and Conciliation Act, 1996
12. Booz Allen & Hamilton Inc v SBI Home Finance Ltd (2011) 5 SCC 532
13. Reserve Bank of India, Report on trend and progress of Banking in India for FY 2020-21.
16. The Financial Express, Potent Tool: Insolvency threat triggers loan recovery of Rs. 5 lakh crore. Available at: Potent tool: Insolvency threat triggers loan recovery of Rs 5 lakh crore | The Financial Express
17. Insolvency and Bankruptcy Board of India, Newsletter, October-December 2021
19. Ebix Singapore Private Limited v Committee of Creditors of Educomp Solutions Limited & Anr 2022 (2) SCC 401
20. Alvarez & Marsal India, The next phase of the IBC must focus on efficiency Available at 122880_india_remaining_ibc_report_07.pdf (alvarezandmarsal.com)
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